As banks across Europe, the U.S. and the Gulf region scrambled to assess their exposure to the Dubai debt crisis, money whooshed out of stocks in a global flight to safety that pushed up of the value of the U.S. dollar and U.S. Treasurys. The blue-chip Dow Jones Industrial Average ($INDU) lost 154.5, or 1.48%, to close at 10,309.9, while the broader S&P 500 ($INX) retreated 19.1, or 1.72%, to finish at 1091.5. The tech-heavy Nasdaq Composite ($COMPX) shed 37.6, or 1.73%, to close at 2138.4.
U.S. markets were closed on Thursday for the Thanksgiving holiday and, as usual, experienced low volume Friday before an early 1 p.m. Eastern close, which likely helped dampen the effects of Thursday's global sell-off.
Dubai, until late Wednesday thought to be a sort of modern-day Shangri La or Timbuktu, raised the specter of looking more like Argentina, the last nation to default on its sovereign debt back in 2001. The city-state, famous for building a palm-shaped island, the world's tallest building, an indoor ski slope and paying Rihanna $500,000 to perform at a New Year's Eve party -- wants a six-month reprieve from repaying a $3.5 billion bond.
European Banks Have the Biggest Exposure
The cost of writing-off Dubai's debt is a tiny fraction of the write-offs from the financial crisis that took $30 trillion off world stock markets in 2008, as DailyFinance's Peter Cohan notes, suggesting that today's sell-off could be an overreaction. That may prove to be the case, considering that U.S. banks own only about 9% of the affected debt, according to the Bank for International Settlements. The biggest creditors are European banks, holding more than 70% of the debt, led by the U.K. with more than 40% exposure.
Howard Penney, managing director of ResearchEdge, a New Haven, Conn., strategy and research firm, doesn't think the Dubai debt crisis will plunge global equity markets to new lows, but he says uncertainty will prevail for some time. More troubling is that this may not be an isolated incident. "The lesson from the financial crisis of 2008 suggests that Dubai World [the state investment vehicle] is probably not the only entity that binged on debt to buy overpriced, rapidly depreciating assets," Penney told clients on Friday.
More alarming is that a rising dollar could cause money to continue to flow out of stocks in a sort of global short squeeze, writes Dennis Gartman, author of the well-regarded investment newsletter bearing his name. "We fear that this news might be the news that tends to push equities around the world over the edge; that brings on a trend toward global protectionism and that pushes the U.S. dollar materially higher... and perhaps violently so," Gartman wrote Friday.
A Short Squeeze in the Dollar?
As DailyFinance has written, the plunging dollar has been boosting share prices, but Gartman, like Nouriel "Dr. Doom" Roubini, fears it has also fueled all manner of asset bubbles by becoming the currency of choice for the international carry trade. A carry trade is where investors borrow cheap currency (until recently, the yen for more than 15 years) to purchase higher-yielding assets, such as stock, bonds, oil, gold and commodities in general. Profit is made by pocketing the difference. As the dollar rises, borrowers of greenbacks are forced to sell those higher-yielding assets in order to buy outright the dollars they've borrowed.
Gartman's worry is that the short squeeze in the dollar will take some time to burn itself out. "This unwinding process shall not likely be a one-off, one- or two-day circumstance," he says. "The 'carry trade' has been increasing in size for weeks and months, and it will take weeks ... at least ... to unwind. Next week, and perhaps the week after and perhaps the week after that we'll see the late arrivals to the trade being forced from their positions by angry and angrier margin clerks."
If Gartman's assessment is correct, the buck has stopped burning for now, putting the global rally in equities, at the very least, on hold.